25 January 2010

Taxing high income earners – putting things into perspective

These days, talks about the crisis occupy much space in media commentaries and political spheres. Following the bail out of major financial institutions, focus has now shifted towards the twin objective of recovering funds and addressing flaws in the incentives that financial agents. Various proposals have become the subject of quite significant debates, for instance concerning whether to tax bonuses. While not necessarily sound given the problems it purports to address, this could be a blessing in disguise.


Opponents of proposals to levy extra fees or taxes argue that these would be both unfair and inefficient. Unfair because, after all, the market pays according to productivity and further taxes would therefore represent an illegitimate theft of duly earned (and already taxed) money. Inefficient, because these taxes would undermine incentives and prevent companies from succeeding in the ‘competition for talent’.

These arguments are not particularly novel and have been applied in the past to oppose any increased fiscal burden on better off segments of society. When considering whether there is indeed a case in favour of these arguments, it is useful to look at the evolution of the distribution of wealth and income in the recent past.

Surely, one would imagine that fears of excessive taxation of high income earners would be based on the observation that this unfortunate group has been hard-pressed to maintain the relatively better off standard of living that it duly deserves. Well to say the least, that’s not exactly what has been happening.

Take income distribution in the US as an illustration. In 1982, the top 20% earned 51.9% of total income while the bottom 40% earned only 12.3%. By 2003, these numbers had become 57.9% and 10.2%. You think that’s shocking? Wait till you see the distribution of wealth. To start with, in 1983 the top 20% owned 81.3% of total wealth and by 2004 this astronomic share reached 84.7%. The bottom 40% owned 0.2% of total. Meanwhile, the top 1% owned more than 150 times that figure (34.3%).

This still is only part of the story, if one looks solely at non home wealth in 2004, the top 1% owned 42.2% of the total and the top 20% owned 92.5%. Clearly, top earners and owners have shown enough solidarity, taxing extra income would be outrageous...

Source: the numbers quoted can be found in table 2, page 11, in: Wolff, E. (2007) Recent trends in Household wealth in the United States: Rising Debt and the Middle class squeeze. Working paper No. 502.

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